Stocks remain volatile with investor concern focused on surging bond yields, Federal Reserve interest rate hikes, and the potential for higher rates to ultimately lead to a significant economic slowdown. These concerns are outweighing still positive economic readings and healthy first-quarter earnings where results are exceeding expectations, which is leading to modest upward revisions for the remainder of 2022.
Stocks would benefit from signs that inflation is peaking, and this week brings lots of inflation data from consumer, producer, and import price readings. Consensus is calling for inflation to recede as the year progresses and supply-chain problems are resolved. A portion of recent inflation is associated with the pandemic and there are early signs these pressures are receding. The speed and magnitude of the potential reduction in inflationary forces will influence the path of future Fed rate hikes, and ultimately the performance of the economy and stock market.
Economic Indicators Suggest Further Growth
The beginning of the month brings key readings on business sentiment and the health of the labor market; both remain consistent with further economic growth.
While the ISM Manufacturing PMI (a monthly business survey) showed activity moderating, it remains consistent with continued manufacturing output and broad economic growth. Importantly, the survey saw breadth improvement, with 17 of the 18 ISM industries expanding last month, and five of the six largest industries reporting moderate-to-strong growth.
The ISM Services PMI also showed activity moderating but is still historically consistent with above-trend growth. While off pandemic highs, supplier deliveries are still very slow by historical comparison, which suggests that vendor performance continues to be affected by supply-chain problems.
Labor Market Remains Strong
April’s employment report showed nonfarm payrolls expanding by 428,000, with the unemployment rate remaining at 3.6%. Average hourly earnings (AHE) rose a less-than-expected 0.3%. On a y/y basis, AHE eased modestly to 5.5% from 5.6% in the previous month. The strongest annual wage growth was once again in the lower-paying industries, such as leisure/hospitality and transportation/warehousing, where labor shortages have been more severe.
In total, annual wage growth for production and nonsupervisory workers was above the national average in four industries, and below it in the remaining nine industries. More importantly, y/y wage growth eased in nine of the 13 industries, a potential sign that wage momentum has peaked.
Aggregate payrolls, which combine payrolls, hours, and earnings, rose 0.6% from the previous month, and were up 10.0% y/y, which is about double the pre-pandemic pace of growth. This provides support for personal income and consumer spending growth, reducing the risk of an imminent recession.
Profits Remain Healthy
With about 90% of the S&P 500’s market capitalization reporting, first-quarter earnings are beating estimates by 6.9%, with 76% of companies topping projections. First-quarter expectations are now for revenues and earnings growth of 13.5% and 10.7%. Results look much more impressive when Financials are excluded, with revenue and earnings projections of 15.0% and 20.6%.
With analyst earnings estimates moving higher, valuation compression has driven the 13% YTD S&P 500 decline. The consensus forward P/E multiple has declined by 16% from 21x at the start of 2022 to 17x today, tracking closely the rise in interest rates and now more in line with historical valuation levels.
Profit growth leadership continues to come from the cyclical Energy and Materials sectors. These sectors have also shown stock market performance leadership this year. The Health Care sector is seeing profits come in better than the broader market and has also outperformed the broader stock market. In addition, valuation for Energy, Materials, and Health Care is more favorable than the broader market. All of this supports our favorable view on these sectors.
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